WILLIAM J. HAYNES, JR., Chief Judge.
A. ANALYSIS OF THE AMENDED COMPLAINT ..............................................745
1. The Parties ................................................................745
2. FUSHI'S FINANCIAL REPORTS ..................................................747 a. Fushi's SWAP Transaction ...............................................747 b. Fushi's Acquisition Practices ..........................................751 c. The Restatements .......................................................755 d. Fushi's Internal Controls ..............................................759 e. Sarbanes-Oxley Certifications ..........................................760 f. Misstatements and Omissions ............................................762 3. INDIVIDUAL DEFENDANTS ......................................................765 a. Defendant Fu ...........................................................765 b. Other Individuals ......................................................767 4. Loss Causation .............................................................768 5. Fraud on the Market ........................................................768 B. CONCLUSIONS OF LAW .............................................................769 1. PLSRA STANDARDS ............................................................774 2. PLAINTIFFS' SECTION 10B-5 CLAIMS ...........................................775 a. Defendants' Misrepresentation and Omissions ............................776 b. Materiality ........................................................... 781 c. Plaintiffs' Scienter Allegations .......................................783 d. Dura's Injury Requirement ..............................................787 3. PLAINTIFFS' SECTION20(A) CLAIMS ............................................788 C. RELIEF .........................................................................790
Plaintiffs, North Port Firefighters' Pension-Local Option Plan ("North Port") and City of Lakeland Employees Pension Plan, filed this action under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78a et seq. (2010), and Rule 10(b) promulgated thereunder, 17 C.F.R. § 240.10b-5 (2010), on behalf of themselves and a class of shareholders against the Defendants, Fushi Copperweld, Inc. ("Fushi") and the following Fushi corporate officers: Li Fu, Joseph J. Longever, Craig H. Studwell, and Wenbing Christopher Wang. In earlier proceedings, the Court appointed City of Lakeland Employees Pension Plan ("Lakeland Employees") as the Lead Plaintiff. Lakeland Employees then filed an amended complaint. (Docket Entry No. 57, Amended Complaint). Plaintiffs assert jurisdiction under 15 U.S.C. § 78aa of the 1934 Act.
In sum, Plaintiffs allege that from August 14, 2007 to May 4, 2011, when Plaintiffs purchased or held Fushi stock, the Defendants engaged in a scheme to portray Fushi as more financially successful than its actual financial condition. Defendants allegedly disseminated or approved false statements about Fushi's financial condition and acquisitions. Plaintiffs alternately allege that the Defendants deliberately disregarded false statements about Fushi to investors. Plaintiffs also allege that the Defendants' alleged misrepresentations and failures to disclose material facts rendered the Defendants' earlier statements about Fushi's finances false. Plaintiffs' specific assertions are that the Defendants' fraudulent scheme and course of business included the improper use of derivatives to inflate artificially Fushi's net income. In addition, Plaintiffs allege that the Defendants improperly treated unqualified acquisitions as "bargain purchases" and such improper accounting treatment deceived the investing public about Fushi's business by artificially inflating the price of Fushi's stock. Plaintiffs allege these improper practices violated Generally Accepted Accounting Principles ("GAAP"). Defendants also allegedly failed to disclose that the Defendant Fu had ownership interests in these acquisitions. These statements and omissions caused Plaintiffs to purchase Fushi's securities at inflated prices. Plaintiffs assert that subsequent disclosures about the accounting violations
Before the Court is the Defendants' motion to dismiss (Docket Entry No. 65), contending, in essence, that Plaintiffs fail to state a claim under Sections 10(b) or 20(a) of the 1934 Act or Rule 10b-5 thereunder. In sum, Defendants' specific contentions are that:
(Docket Entry No. 69, Defendants Memorandum in Support of Motion to Dismiss).
In their response, Plaintiffs assert, in sum: (1) that their complaint adequately pleads that Defendants made false, misleading, and material misstatements and omissions about Fushi's financial condition; (2) that under the applicable law, the totality of circumstances gives rise to a strong inference of scienter; and (3) that Plaintiffs' sufficiently plead loss causation. (Docket Entry No. 76, Plaintiffs' Memorandum in Opposition to Defendants' Motion to Dismiss). The Court set oral argument that was reset upon the parties' request.
Based upon the amended complaint and the parties' submissions and applying the holistic approach, the Court concludes, in sum, that Plaintiffs' amended complaint states plausible securities claims given Plaintiffs' factual allegations of the Defendants' admitted improper use of a SWAP to inflate the value of Fushi stock, the Defendants' admitted improper accounting treatment of bargain acquisitions, the Defendants' failure to disclose the Defendant Fushi's ownership interests in those acquisitions and insiders' false statements about the Defendants' financial practices.
According to Plaintiffs' amended complaint,
Fushi is based in Dalian, China and produces bimetallic wire products that are sold primarily to customers in the telecommunications, electrical utility, and transportation industries throughout the world. Id. at ¶ 2. Fushi's common stock was listed and traded on the National Association of Securities Dealers Automated Quotations ("NASDAQ") under the symbol FSIN during the Class Period. Id. at ¶ 1. Fushi's business is conducted principally through wholly owned subsidiaries: Fushi International ("Dalian"), Bimetallic Cable Co. Ltd. and Copperweld Bimetallics, LLC ("Copperweld"). Id. at ¶ 25. Fushi acquired 100% of Copperweld in 2007. Id. During the Class Period, Fushi had approximately 600 employees, of whom 54% were in manufacturing. Id. The remaining employees were engineers or salespersons. Id.
Defendant, Li Fu ("Fu"), served as Fushi's chief executive officer from December 2005 through November 2009 and thereafter as Fushi's co-chief executive officer. Id. at ¶ 18. Since December 2005, Fu also served as Chairman of the Fushi's Board. Id. During the Class Period, Fu prepared and signed Fushi's 10-K Forms, filed with the Securities and Exchange Commission ("SEC"). Fu attested his review of the filings' contents for any untrue statements of a material fact or omissions that would render the statements misleading. Id. Plaintiffs allege that Fu also issued press releases and participated in Fushi's conference calls (through an interpreter) with investors and was the primary person with knowledge about the Fushi's business, financial reports, and business practices. Id.
Since November 2009, Defendant Joseph J. Longever ("Longever") served as Fushi's co-chief executive officer and as a Fushi director since June 2010. Id. at ¶ 19. Longever, a Franklin, Tennessee resident, served as Fushi's chief commercial officer from July 2009 to November 2009. Id. Longever prepared and signed Fushi's 10-K Forms during the Class Period and attested to their accuracy. Id. Longever also issued press releases and participated in conference calls with investors as a person with knowledge about Fushi's business, financial reports, and business practices. Id.
Defendant Wenbing Christopher Wang ("Wang") served as Fushi's president and director since January 2008. Id. at ¶ 20. Wang was also Fushi's chief financial officer from December 2005 to August 2009 and was interim chief financial officer from February to October 2010. Id. Defendant Wang also prepared and signed the Fushi's SEC 10-K Forms during the Class Period and reviewed and attested to their accuracy. Id. Wang also issued press releases and participated in conference calls with investors representing himself as a primary person with knowledge about the Company's business, financial reports, and business practices. Id.
As to the other individual defendants, beginning in October 2010. Defendant Craig H. Studwell ("Studwell") served as Fushi's chief financial officer and executive
According to Plaintiffs' amended complaint, beginning on August 14, 2007, Fushi issued a press release of its 2007 second quarter financial results. Id. at ¶ 67. In sum, Defendants reported Fushi's $26 million in revenue and $7 million with $0.28 diluted earnings per share ("EPS") for that quarter. Id. Fushi issued press releases at the end of each quarter and year with this same financial information on November, 14, 2007, March 12, May 14, August 12, and November 13, 2008, March 12, May 11, August 5, and November 6, 2009, March 10, May 4, August 4, and November 2, 2010. Id. at ¶¶ 70, 72, 76, 79, 82, 85, 89, 92, 95, 101, 105, 109, 112. Collectively, these press releases also contain the cited figures of revenue and earnings.
Revenue Net Income Diluted EPS
3d 2007 $32 million $8.2 million $0.33
4th 2007 $265 million $6.4 million $0.23
Full Year 2007 $128 million $485 million $1.06
1st 2008 $54 million $7.6 million $0.26
2d 2008 $625 million $7.3 million $0.25
3d 2008 $63.8 million $9 million $0.31
4th 2008 $41 million $4.6 million $0.15
Full Year 2008 $221 million $285 million $1.00
1st 2009 $353 million $3.1 million $0.11
2d 2009 $483 million $1.6 million $0.06
3d 2009 $47.7 million $9.2 million $0.31
4th 2009 $51.7 million $10 million $0.34
Full Year 2009 $183 million $24 million $0.84
1st 2010 $595 Million $7.4 million $0.21
2d 2010 $69 million $13.4 million $0.35
3d 2010 $665 million $13 million $0.34
Id. at ¶¶ 70, 72, 76, 79, 82, 85, 89, 92, 95, 101, 105, 109, 112.
With the exception of the November 14, 2007 press release, the Defendants also hosted conference calls with investors after the press releases for these time periods. Id. at ¶¶ 73, 77, 80, 83, 86, 90, 93, 96, 102, 106, 110, 113. In each call, Defendants commented on Fushi's financial standing at that time and gave reasons for any changes in Fushi's value over the period. Id. Plaintiffs allege that Defendant Wang spoke during the November 13, 2008, March 12, 2009, and March 10, May 4, August 4, and November 2, 2010 conference calls; that Defendant Zhang spoke during the November 6, 2009 call; and Defendant Longever spoke during the March 10, 2010 call. Id. at ¶¶ 83, 86, 96, 102, 104, 106, 108, 110, 113.
On April 10, 2007 and in its August 14, 2007 SEC10-Q Form, (effective January 24, 2007), Fushi disclosed its "Derivative Financial Instrument," that is a cross currency interest swap ("SWAP"), a derivative transaction. Fushi described this SWAP as "a cross currency hedge" and a "cash flow hedge" that was "to hedge the risk of rising interest rates on their variable interest rate debt." Id. at ¶ 34; 69. The SWAP'S stated purpose was to address Fushi's interest rate risk on Fushi's variable rate interest payments in U.S. dollars on its $40 million high yield debt. Id. at ¶ 34. Under the SWAP, Merrill Lynch Capital Services, Inc. ("Merrill
Fushi's report also stated that this "Derivative Financial Instrument," or SWAP would be treated "in accordance with FAS No. 133, `Accounting for Derivatives Instruments and Hedging Activity,' which requires the derivative to be carried on the balance sheet at fair value and to meet certain documentary and analytical requirements to qualify for hedge accounting treatment." Id. at ¶ 69. Fushi asserted that this "derivative qualifies for hedge accounting under FAS 133 and, accordingly, changes in the fair value is reported in accumulated other comprehensive income, net of related income tax effects." Id. Plaintiffs cited the following statements from Fushi's Form 10-Q for the second quarter of 2007 about the April 10 SWAP as false:
Id. at ¶ 36 (emphasis in complaint).
Defendants note their disclosures about the nature, risks and the accounting treatment for this SWAP in Fushi's SEC Form 10-Q for the quarter that ended June 30, 2007:
(Docket Entry No. 66-4 at 30-32) (emphasis added).
According to Plaintiffs, for the SWAP to be "highly effective," GAAP standards require that at the inception of the SWAP, Fushi must expect that the changes in the variable rate of interest in U.S. dollars would be almost fully offset by the changes in the RMB/U.S. rate of exchange on the fixed rate interest, over the term of the SWAP. (Docket Entry No. 57, Amended Complaint at ¶ 38). Plaintiffs allege that "at the inception of the SWAP, as well as on an ongoing basis Fushi could not possibly expect that the changes in the LIBOR [London Interbank Offered Rate] would be almost fully offset by the changes in the RMB/U.S. exchange rate." Id. Thus, Plaintiffs allege that "[n]o rational person in the business could expect, for example, that a rise in the LIBOR would necessarily be accompanied by an offsetting change in the RMB/U.S. exchange rate, hand-in-hand." Id.
Plaintiffs' allegations are reflected in statements in Fushi's SEC Form 8-K, dated March 24, 2011, that its SWAP did not qualify under stated accounting standards, as Defendants earlier told investors. In a word, Fushi explained that this SWAP did not qualify for cash flow hedge accounting treatment because the SWAP did not provide an effective hedge against Fushi's variable rate interest payments on its high yield debt. The amended complaint states:
Id. at ¶ 34 (emphasis in complaint). Plaintiffs allege that Fushi was never exposed to foreign currency risk on its high yield notes. Id. at ¶ 45.
Plaintiffs also allege that "Fushi knew that the SWAP would cause the Company to be exposed to an additional foreign currency risk: on those interest payments in RMB" and "knew, therefore, that the SWAP could not possibly comport with the GAAP requirement that the SWAP be `highly effective' at the inception of the transaction." Id. at ¶ 41. This foreign currency risk is based upon the interest payments in RMB. Id. This risk is reflected in Fushi's 2007 10-K Form that states: "[i]f the RMB depreciates against the U.S. Dollar, the value of our RMB revenues and assets as expressed in our U.S. Dollar financial statements will decline." Id. In their amended complaint, Plaintiffs proffer a chart to depict Fushi's SWAP with Merrill Lynch. Id. at ¶ 43. Under the SWAP transaction, (1) Merrill Lynch agreed to pay Fushi the variable rate interest in U.S. dollars; (2) Fushi used such payment to pay the debt holders of Fushi's $40 million high yield notes; and (3) Fushi agreed to pay Merrill Lynch a fixed rate of interest in RMB. Id. at ¶ 44. Plaintiffs allege that the high yield notes and interest that Merrill Lynch paid Fushi were both in U.S. dollars. Id. at ¶ 45.
Moreover, the Plaintiffs allege that Fushi's reporting currency and functional currency in the United States were both in U.S. dollars. Id. at ¶ 45. Under such a transaction there is not any reasonable expectation that changes in the variable rate of interest in U.S. dollars would be almost fully offset by changes in the RMB/U.S. rate of exchange on the fixed rate interest over the SWAP'S term. Id. at ¶ 44. Fushi's statement in its March 24, 2011 Form 8-K acknowledged that:
Id. at ¶ 45.
Plaintiffs assert that at its inception and thereafter, Fushi knew that under this SWAP, changes in the LIBOR would be almost fully offset by the changes in the RMB/U.S. exchange rate. Id. at ¶ 46. Thus, the Defendants' improper accounting must have been either intentional or was done with reckless disregard of the actual facts and was not the product of an innocent mistake or mere error. Id. Plaintiffs further allege that as a result of the improper accounting of this SWAP, Fushi's financial statements were materially false and misleading from 2007 through the first quarter of 2010. Id. at ¶ 30.
Plaintiffs allege that Fushi knew or recklessly disregarded the fact that this SWAP was not qualified to use cash flow hedge because all criteria in Financial Accounting Standards ("FAS") 133 had to be met. Id. at ¶¶ 28-29, 37. Specifically, Plaintiffs cite the section titled Accounting for Certain Derivative Instruments and
Plaintiffs allege that Defendants knew that treatment, disclosure, and reporting of the SWAP as a "cash flow hedge," was false and also knew that charges against net income could be improperly dodged. Id. at ¶ 39. Plaintiffs assert that this error was not due to complex accounting requirements because Fushi's SWAP used a "plain vanilla" foreign currency/cross currency interest rate swap that do not involve complex accounting rules. Id. at ¶ 42. For the characteristics of a plain vanilla swap, Plaintiffs allege:
Id.
With this SWAP, in 2007, Plaintiffs allege that Fushi was able to inflate net income by $5.6 million or 24% while evading reporting substantial losses that would otherwise have materially and adversely affected the Company's bottom line net income. Id. at ¶ 47. Fushi's restatements resulted in a decrease in Fushi's net income of $5.6 million in 2007; an increase in net income of $2.7 million in 2008; a decrease in net income of $2.1 million in 2009; and a decrease in net income of $5.0 million for the quarter ended March 31, 2010. Id. at ¶ 30. The cumulative financial impact of Fushi's improper SWAP accounting during the period from January 24, 2007 through March 31, 2010 represents an overstatement net income of $10.0 million. Id.
On January 21, 2010, acting through its subsidiary Fushi International (Dalian) Bimettalic Cable Co. Ltd., Fushi announced its "`definitive agreement to acquire Dalian Jinchuan Electric Cable Co., Ltd. ("Dalian Jinchuan") for approximately $10.2 million,'" with "`the transaction to be finalized during the course of the first quarter 2010.'" Id. at ¶ 98. Fushi described
Defendants note that in Fushi's SEC Form 10-Q issued on November 8, 2010, Fushi made the following disclosures about the Jinchuan acquisition: (1) The Company paid $5,075 million in cash to acquire Jinchuan, with additional payments of up to $5,075 million to be paid depending upon whether Jinchuan reached certain performance targets for 2010. See (Docket Entry No. 66-10 at 3, March 24, 2011 Form 8-K); (2) The Company retained an independent appraisal of Jinchuan by Liaoning Hongxing Appraisal, LLC ("Liaoning Hongxing") that appraised the fair value of Jinchuan's net assets at $13,455,950, approximately $3.3 million above the purchase price. (Docket Entry No. 66-11 at 50); and (3) in reliance upon this independent appraisal, the Company recognized a $3.3 million gain flowing from its "bargain acquisition" of Jinchuan. Id.
Fushi's February 1, 2010 press release announced the closing of a public offering of 7,475,000 shares of Fushi common stock at $8 per share, yielding net proceeds of $55.4 million (including the underwriters' over-allotment of 975,000 shares of common stock). (Docket Entry No. 57, Amended Complaint at ¶ 99). In reference to this offering, Fushi's May 4, 2010 press release stated:
Id. at ¶ 105. Plaintiffs assert that the cash from this stock offering was used to continue Defendants' debt reductions while maintaining cash reserves around $79 million. Id. at ¶ 100.
On May 26, 2010, Fushi announced that its agreement to acquire 100% of Hongtai, a leading manufacturer of bimetallic wire in Southeast China, for approximately $3.9 million, with $1.3 million in cash and $2.6 million in restricted stock. Id. at ¶ 108. Fushi stated its expectation that the transaction would be finalized during the second quarter of 2010. Id. Fushi described Hongtai as "`a leading manufacturer of bimetallic wire in Southeast China, principally [CCA] and copper-clad aluminum magnesium.'" Id. Hongtai's net assets were stated to be at $5.7 million, approximately
On December 3, 2010, financial analysts at Jefferies & Company reported Fushi's decreasing stock value citing "the discovery of potential accounting irregularities at a different Chinese-based U.S. traded company that is audited by the same firm [Fushi] uses." (Docket Entry No. 57, Amended Complaint at ¶ 115). The Jefferies analyst also noted that Fushi acted to offset this concern and "reiterated to [Jefferies] its confidence in its accounting policies and their application." Id. (emphasis omitted). Based upon these accounting irregularities, Plaintiffs allege that Fushi's SEC reports, statements on conference calls, and press statements about its financial conditions were materially misleading and did not fairly represent Fushi's actual financial condition during the Class Period. Id. at ¶¶ 75, 88, 104, 116.
Plaintiffs allege that Fushi did not reassess whether the assets acquired and liabilities assumed were correctly identified, as required by FAS No. 141R, ¶ 38. Id. at ¶ 53. Plaintiffs allege Fushi violated GAAP by (1) materially overstating "the fair value of certain property, plant and equipment" that Fushi acquired in its purchases of Dalian Jinchuan Jinchuan and Hongtai; (2) improperly treated these acquisitions as "bargain" purchases under Fushi's purchase price accounting; and (3) improperly recognized gains on these transactions. Id. (citing Form 8-K, Mar. 24, 2011). According to the amended complaint, a "bargain" purchase occurs when the fair value of the acquired net assets in a business combination exceeds the consideration the acquirer paid. Id. at ¶ 49. Plaintiffs allege that such bargain purchases are rare and unusual, citing FAS No. 141R on the accounting rules regarding such purchases:
Id. at ¶¶ 50-51 (emphasis in complaint).
Plaintiffs assert that the Financial Accounting Standards Board ("FASB") distinguishes between a "bargain" purchase and measurements errors:
Id. at ¶ 51 (emphasis added).
Plaintiffs also cite FASB procedures describe how to determine if a "bargain" purchase is legitimate or permissible:
Id. at ¶ 52.
Plaintiffs assert that GAAP expressly warns financial statement preparers that "bargain" purchases are "anomalous" and advises that the fair value measurements for such purchases should be investigated and rechecked for overstatements of net assets. Id. at ¶ 31. Plaintiffs assert that Fushi did not heed FASB's warnings about bargain purchases and did not maintain internal control systems to minimize intentional and unintentional errors. Id. Plaintiffs allege that Fushi knew the valuations of these acquired net assets were likely materially inflated. Id. Thus, Plaintiffs allege that the Defendants' statements of the value of these acquisitions were false or the Defendants recklessly disregarded the facts and circumstances of the values of these acquisitions. Id. As a result, Plaintiffs allege that Fushi's statements in documents, including its 2007 Form 10-K about effective internal control over financial reporting during the relevant time period, were false and misleading. Id. at ¶ 30. Plaintiffs further allege that Fushi was motivated to treat the purchases as "bargain" purchases to recognize gains of $3.3 million in the first quarter and $1.8 million in the second quarter of 2010. Id. at ¶ 31. Plaintiffs characterize these Fushi gains as "bogus," because Fushi was required to restate its financial statements as a result of the allegedly false and misleading financial statement resulting from the purchases. Id. at ¶ 31-32. These restatements allegedly reduced Fushi's earnings by $3.3 million in the first quarter and $1.8 million in the second quarter of 2010, resulting in a $5.1 million overstatement of Fushi's gains. Id. Plaintiffs allege that Fushi failed to recognize approximately an additional $1.7 million of goodwill ($1.1 million from Dalian Jinchuan and $0.6 million from Hongtai) on its balance sheets for the second quarter of 2010. Id.
Between 2007 and January 24, 2011, Fushi's independent accounting firm was Frazer Frost, LLP. Plaintiffs allege that on January 24, 2011, Fushi announced that its replacement of Frazer Frost with KPMG as Fushi's registered independent public accounting firm. Id. at ¶ 142. Frazer Frost allegedly served as Fushi's accounting firm in each of the years that were restated. Id. In its January 24, 2011 SEC Form 8-K Fushi announced that "Frazer's report on the Company's financial statements for the fiscal years ended December 31, 2008 and 2009 contained no adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principal." (Docket Entry No. 66-5 at 2). In addition, Fushi's report stated, "[d]uring the period from January 1, 2008 through the date of Frazer's dismissal, there were no disagreements with Frazer on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Frazer, would have caused Frazer to make reference to the subject matter of the disagreements in connection with Regulation S-K." Id.; see also (Docket Entry No. 57, Amended Complaint at ¶ 142).
Fushi allegedly emphasized that this change was not the result of a disagreement with Frazer Frost and Frazer Frost's prior reports on Fushi's financial statements were accurate. Id. Plaintiffs allege that KPMG immediately discovered that Fushi's prior financial statements for 2007-2009 and the first three quarters of 2010 were false. Id. at ¶ 143. Plaintiffs assert that this quick discovery supports an inference of scienter against the Defendants. Id. Plaintiffs also cite former high-level Fushi executive who has knowledge of Fushi's executive team's operation during
On March 11, 2011, after the closure of the market, Fushi announced its reevaluation of its accounting treatment of its SWAP and its "bargain purchase" acquisitions of Dalain Jinchuan and Hongtai. Id. at ¶ 117. In addition Fushi announced its inability to meet SEC rules to file its Form 10-K by the deadline Id. As discussed below, Fushi announced its projected positive financial performance and provided a reason for its stock value decrease. Fushi also stated that "since the Company was not exposed to foreign currency risk on the high yield notes, the SWAP did not qualify for hedge accounting and all changes in fair value of the SWAP should have been recognized in earnings." (Docket Entry No. 66-15 at 2, March 24, 2011 Form 8-K). As to the acquisitions, Fushi announced that "[d]uring the year-end closing process, management of the Company identified certain errors in the original purchase price allocation with respect to the fair value of certain property, plant and equipment the Company acquired in the Hongtai and Jinchuan acquisitions." Id. In its March 11, 2011 Form 8-K, Fushi stated that although the accounting treatments in question related only to non-cash and non-operating items, the Company's review would result in a delay in the filing of the Company's annual Form 10-K. Id. 66-14 at 5, Mar. 22, 2011 Form 8-K.
On March 11, 2012 Fushi stock closed at $9.42 and for the next two months fell to $5 to $7 a share. (Docket Entry No. 69, Defendants' Memorandum in support of Motion to Dismiss at 33). Defendants note the Tsunami that struck Japan on March 11, 2012 that had an adverse effect on the Asian stock, but on March 14, 2012, Fushi's stock price was $8.98 a share. Id. On March 29, 2011, Fushi disclosed that restatements of its financial statement would be forthcoming for 2007 through the first three quarters of 2010. These restatements revealed that in 2007, Fushi's income was overstated 24%; in 2009 by 10% and the second quarter by 9%. Fushi states that its net income was understated in 2008 by 9% and 19% for the first and third quarters of 2010. Id. at 16.
Plaintiffs allege that in its press release about its reevaluations of the application of GAAP and certain accounting treatments of its SWAP and acquisitions for its 2007-2009 financial results and the financial statements, the Defendants stated:
(Docket Entry No. 57, Am. Compl. at ¶ 117). Fushi's press release also assured investors of the strength of Fushi's business as reflected in Defendant Longever's statement:
Id. at ¶ 118. In response to the announcement of the restatements, Fushi stock allegedly dropped 2.3% that Plaintiffs attribute to the exposure of the artificial inflation of the stock price. Id. at ¶ 124. Fushi's stock closed on March 11, 2011 at $9.42 and opened on March 14, the next trading day, at $8.98 and remained at $8's for the ensuing two months, but fell to the $5 to $7 range until closing at $8.27 on February 9, 2012. (Docket Entry No. 69, Defendants' Memorandum in Support of Motion to Dismiss at 33).
Financial analysts Rodman & Renshaw allegedly noted the first quarter results as disappointing:
(Docket Entry No. 57, Amended Complaint at ¶ 127 (emphasis added)). Plaintiffs assert that as a result of this disappointment, the value of Fushi stock dropped an additional 3.4%. Id. at ¶ 131.
Plaintiffs allege that by March 14, financial analysts responded to this news of Fushi's delay in filing of the Form 10-K as a "concern." Id. at ¶ 119. Plaintiffs allege
Plaintiffs allege that on March 29, 2011, Fushi filed a Form 8-K with the SEC disclosing that Fushi's audit committee had concluded that the previously reported financial statements for the years ended December 31, 2009, 2008, and 2007 and its unaudited interim financial statements for the quarters ended March 31, 2010, June 30, 2010, and September 30, 2010 should be restated and should no longer be relied upon. Id. at ¶ 121. Fushi stated that this restatement was due to the misapplication of the GAAP to the SWAP and the acquisitions of Dalian Jinchuan and Hongtai. Id. Plaintiffs cite Jeffries analysts' statements that "we do consider [the restatements] material to earnings, as they all exceed 8%." Id. at ¶ 123.
According to Plaintiffs, a result of the accounting errors was that Fushi's net income was overstated in 2007 (by 24%), 2009 (by 10%), and the second quarter of 2010 (by 9%); was understated in 2008 (by 9%); overstated in the first and third quarters of 2010 by 19%. Id. at ¶ 33. Plaintiffs note that Fushi missed its projected non-GAAP income by 39%. Id. at ¶ 127. The value of plant and equipment was overstated by approximately 4% over the first three quarters of 2010, and goodwill was undervalued by 100% during that time period with the net effect on the value of total assets of a 1% overstatement. Id. at ¶ 33; (Docket Entry No. 66-16 at 50; 66-17 at 35; 66-19 at 41). Defendants note that for the putative class period, the total overstatement of Fushi's net income is 4%. (Docket Entry No. 69, Defendants' Memorandum at 23).
Plaintiffs assert that Defendants' decision to adjust Fushi's previous financial statements is an admission that the financial results originally issued during the Class Period and its public statements regarding those results were materially false and misleading and that the financial statements reported during the Class Period were incorrect based on information available to the defendants at the time the results were originally reported. (Docket Entry No. 57, Amended Complaint at ¶ 122).
Plaintiffs allege that on May 2, 2011, in spite of the delay and allegedly because of the positive statements about 2011, financial analysts at Roth Capital Partners ("Roth") expected Fushi to meet expectations for the first quarter of 2011. Id. at ¶ 125. On May 4, 2011, Fushi issued a press release on its first quarter 2011 financial results, with $65.9 million reported revenue and $6.8 million, or $0.18 diluted EPS, below the alleged analyst estimate of $0.23. Id. at ¶ 126.
Fushi's release attributed its lack of performance to customers not stocking Fushi products at the same levels as past quarters and customers were drawing down on their inventories. Id. Defendant Longever's actual statement was:
Id. at 146 (emphasis added). Plaintiffs assert that this characterization about inventory is refuted by former Fushi employees. According to Plaintiffs, a former high-level Fushi executive reports that during the Class Period that Fushi's customers do not keep inventory on hand nor have warehouses for inventory, and only purchase products for immediate use. Id. at ¶ 128. A former Fushi sales representative employed during the Class Period also allegedly stated that customers did not sit on inventory. Id.
Plaintiffs assert that Fushi's failure to implement a "Western style" of internal controls contributed to the Defendants' alleged wrongdoing. Id. at ¶ 55. Quoting Fushi's SEC Form 10-K from 2007, Plaintiffs allege an awareness of the deficiency on the part of Fushi: "PRC [People's Republic of China] companies have historically not adopted ... a Western style of management and financial reporting concepts and practices, ... which includes strong corporate governance, internal controls and, computer, ... financial and other control systems.... [T]here have been historical deficiencies with our internal controls...." Id. at ¶ 56. Plaintiffs cite three deficiencies in Fushi's internal control structure: (1) lack of independent evaluation and analysis of the substance and nature of the underlying transactions; (2) lack of assessments and responses to the risks of inaccurate financial reporting; and (3) failures to monitor the accuracy of the data for the SWAP and the acquisitions of Dalian Jinchuan and Hongtai. Id. at ¶ 57. Plaintiffs assert that Fushi's failure was contrary to the 1934 Act Rules 13a-15(f) and 15d-15(f) that require management of public companies to establish and maintain adequate internal control over financial reporting. Id. at ¶ 65. Rule 13a-15(f) of the 1934 states:
Id.
Plaintiffs allege that during the class period, Fushi represented that its internal controls of financial reporting were effective because of its utilization of Committee of Sponsoring Organizations of the Treadway Commission ("COSO") criteria in Fushi's "Internal Control-Integrated Framework." Id. at ¶ 56. Plaintiffs assert that in fact, Fushi failed to comply with essential components of COSO. Id. at ¶ 57. In particular, Plaintiffs allege that Defendants Fu, Longever, and Wang falsely stated that internal controls were in place to ensure the reliability of Fushi's financial reporting and that those internal controls were in accordance with COSO standards. Id. Plaintiffs's specific allegations on Fushi's deficiencies and the Defendants' violation of COSO standards are the lack of the following:
Id. (emphasis in complaint).
Plaintiffs assert that Fushi's internal control failure were egregious because: (1) the SWAP and the two "bargain" purchases were highly unusual transactions for Fushi; (2) the pertinent GAAP standards for those transactions are not complex; and (3) Fushi's accounting treatments of the transactions "conveniently" resulted in material overstatements of Fushi's net income during the relevant period, particularly in the year of those transactions. Id. at ¶ 58. Plaintiffs further allege that according to a former high-level executive at Fushi, Defendant Fu maintained sole control over Fushi's finances and expenditures and thereby caused the violations of the COSO internal control principles requiring segregation of duties and independent checks for these transactions. Id. at ¶ 59.
Defendant Wang filed Fushi's August 14, 2007 Form 10-Q for the preceding quarter with details of Fushi's financial results for the quarter with certifications required by the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). Defendants Fu and/or Wang signed each certification that stated:
Id. at ¶¶ 64, 68.
Additional Sarbanes-Oxley certifications with substantially similar statements are in Fushi's 10-Q and 10-K Forms dated March 12, March 17, May 14, August 13, and November 13, 2008; March 16, May 11, August 10, and November 9, 2009; March 16, May 7, August 10, and November 8, 2010. Id. at ¶¶ 71, 74, 78, 81, 84, 87, 91, 94, 97, 103, 107, 111, 114. Defendants other than Fu and Wang signed these forms on three occasions: (1) the November 9, 2009 Form 10-Q signed by Defendants Fu and Zhang; (2) the March 1, 2010 Form 10-K signed by Defendants Fu, Wang, and Longever; and (3) the November 8, 2010 Form 10-Q signed by Defendants Fu and Studwell. Id.
Plaintiffs allege that the Defendants' Sarbanes-Oxley certifications included specific certifications of their evaluations of: (1) Fushi's disclosure controls and internal controls over its financial reporting, and (2) the effectiveness of Fushi's disclosure controls and internal controls over its financial reporting. Id. at ¶ 64. Plaintiffs assert that these certifications were false for the last three quarters of 2007, all of 2008 and 2009, and the first three quarters of 2010. Id. Plaintiffs allege that Fushi admitted on April 5, 2011 in its delayed SEC Form 10-K for the year ending December 31, 2010, that the previously reported financial statements for the years 2007-2009 and its unaudited interim financial statements for the quarters first three quarters of 2010 were materially false, should be restated, should no longer be
Plaintiffs further alleges that these certifications were false because (1) the Defendants admitted that Fushi's financial reporting regarding the SWAP and the two "bargain" purchases materially overstated Fushi's net income; (2) Defendants knew that Fushi did not comply with GAAP; (3) Defendants knew that Fushi's internal controls were inadequate and that Fushi failed to comply with COSO requirements; and (4) Fushi's Forms 10-Q/10-K for the periods in question did not comply with Rule 13a-15 of the 1934 Act that the "issuer's management must evaluate, with the participation of the issuer's principal executive and principal financial officers, or persons performing similar functions, the effectiveness of the issuer's disclosure controls and procedures, as of the end of each fiscal quarter." Id. at ¶ 65.
Plaintiffs assert that if the Defendants had actually reviewed and evaluated Fushi's internal control over financial reporting, as stated in their Sarbanes-Oxley certifications, then the Defendants would have discovered the cited issues with the SWAP and bargain purchases as well as the internal control deficiencies on these transactions. Id. at ¶ 66. Thus, Plaintiffs assert that the Defendants either knew of the alleged misstatements or knowingly failed to perform their stated reviews of Fushi's finances, internal controls and disclosure controls. Id. Plaintiffs assert that Defendants therefore acted with knowledge or reckless disregard as to the falsity of the Sarbanes-Oxley certifications when they signed them. Id.
Plaintiffs allege Fushi's alleged misstatements were material misrepresentations about Fushi's actual financial conditions in the last three quarters of 2007, the years of 2008 and 2009, and the first three quarters of 2010. Id. at ¶ 60. Plaintiffs also submit the following chart as a summary of Fushi's alleged financial misstatements:
Fushi Copperweld Inc. and Subsidiaries
Summary of Fushi's Key Financial Misstatements
(All Figures in U.S. Dollars, Except Percentages)
Bargain
Purchase Plant and Total
Net Income Gain Equipment Goodwill Assets
Year ended 12/31/2007; as Reported 29,505,627
Year ended 12/31/2007; as Restated 23,885,466
Year ended 12/31/2007; Amount 5,620,161
Over/(Under)stated
Year Ended 12/31/2007; Percentage 24%
Over/(Under)stated
Year ended 12/31/2008; as Reported 28,474,509
Year ended 12/31/2008; as Restated 31,205,800
Year ended 12/31/2008; Amount (2,731,291)
Over/(Under)stated
Year Ended 12/31/2008; Percentage (9%)
Over/(Under)stated
Year ended 12/31/2009; as Reported 23,994,386
Year ended 12/31/2009; as Restated 21,911,788
Year ended 12/31/2009; Amount 2,082,598 Over/(Under)stated Year Ended 12/31/2009; Percentage 10% Over/(Under)stated Quarter ended 03/31/2010; as Reported 7,370,760 3,305,013 125,677,015 331,002,731 Quarter ended 03/31/2010; as Restated 9,072,539 0 121,844,394 567,892 327,738,002 Quarter ended 03/31/2010; Amount (1,701,779) 3,305,013 3,832,621 (567,892) 3,264,729 Over/(Under)stated Quarter Ended 03/31/2010; Percentage (19%) N/A 3% (100%) 1% Over/(Under)stated Quarter ended 06/30/2010; as Reported 13,439,809 1,765,376 130,964,932 348,069,517 Quarter ended 06/30/2010; as Restated 12,317,143 0 125,365,827 1,669,789 343,525,029 Quarter ended 06/30/2010; Amount 1,122,666 1,765,376 5,599,105 (1,669,789) 4,544,488 Over/(Under)stated Quarter Ended 06/30/2010; Percentage 9% N/A 4% (100%) 1% Over/(Under)stated Quarter ended 09/30/2010; as Reported 12,870,762 129,748,890 387,416,290 Quarter ended 09/30/2010; as Restated 12,922,371 124,275,549 1,669,789 382,997,566 Quarter ended 09/30/2010; Amount (51,609) 5,473,341 (1,669,789) 4,418,724 Over/(Under)stated Quarter Ended 09/30/2010; Percentage 0% 4% (100%) 1% Total 01/01/2007-09/30/2010; As 115,655,8537 Reported Total 01/01/2007-09/30/2010; As 111,315,107 Restated Total 01/01/2007-09/30/2010; Amount 4,340,746 Over/(Under)stated Total 01/01/2007-09/30/2010; 4% Percentage Over/(Under)stated Total 03/30/2010-09/30/2010; As 386,390,837 0 1,066,488,538 Reported Total 03/30/2010-09/30/2010; As 371,485,770 3,907,470 1,054,260,597 Restated Total 03/30/2010-09/30/2010; Amount 14,905,067 (3,907,470) 12,227,941 Total 03/30/2010-09/30/2010; 4% (100%) 1% Percentage Over/(Under)stated
Plaintiffs cite concepts and standards from the SEC's Staff Accounting Bulletin ("SAB") No. 99, issued in August 1999:
Id. at ¶ 61.
Plaintiffs assert that SAB No. 99 also requires a full analysis of all relevant considerations, rather than a simple quantification of the magnitude of misstatement. Id. at ¶ 62. Under SAB No. 99 a reasonable person standard applies to determine if a matter is material. Id. Plaintiffs assert Defendants' statements characterizing accounting errors as "quantitatively small" are material misstatements necessary to conceal failures to meet expectations, to smooth earnings artificially, or to give a false impression of earnings stability. Id. at ¶ 63. For materiality, Plaintiffs also focus on the quantitative value of the misstatement in the year of each pertinent transaction. Id.
Aside from the evaluations of these acquisitions, Plaintiffs also allege a former high-level Fushi executive stated that Defendant Fu had ownership interests in Dalian Jinchuan and Hongta. Id. at ¶ 54. According to Plaintiffs, Fu's ownership interests in these companies that Fushi purchased, cause violations of GAAP requirements on purchases of a related company:
As to the extent of disclosures, GAAP provides:
Id. (emphasis in complaint). Defendants filed a recent Fushi SEC report that acknowledges Fu's ownership interests in these entities. (Docket Entry No. 106, attachments thereto).
Plaintiffs identify former high-level Fushi executives who left Fushi during the Class Period to avoid association with Fushi's misrepresentations to investors. Id. at ¶ 144. Plaintiffs refer to a former Fushi
Plaintiffs assert that the Individual Defendants acted knowing or with reckless disregard of the false nature of Fushi's public documents and statements about Fushi's actual financial condition as well as the Defendants' dissemination of these false statements to the investing public. Id. at ¶ 133. Plaintiffs allege that the Individual Defendants' behavior constituted substantial participation or acquiescence in violations of federal securities laws. Id. at ¶ 133. Accordingly, Plaintiffs state:
Id.
Fu was Fushi's chief executive officer from December 2005 through November 2009, and thereafter was Fushi's co-chief executive officer. Id. at ¶ 18. Since December 2005 Fu also served as Fushi's chairman of its board of directors. Id. As pertinent here, Fu prepared and signed Fushi's SEC 10-K Forms. Id. In October and November 2008, Fu sold 10% of his Fushi shares. Id. at ¶ 137. In 2009, engaged in stock backed borrowing by pledging 7 million shares of Fushi stock for a $15 million loan with J.P. Morgan. Id. at ¶ 136. Plaintiffs allege Fu's "personal business" loans were devices to inflate Fushi's stock. Id. For this contention, Plaintiffs cite the Roth's financial analysts' statement:
Id. (emphasis in original and added).
On February 10, 2009, as Fushi's chairman and chief executive officer, Defendant Fu filed a Schedule 13D/A that announced that between October 22 and November 3, 2008, Fu sold 1,099,835 shares of Fushi
(Docket Entry No. 57, Amended Complaint at ¶¶ 136-139) (emphasis in original).
For his July 10, 2008 loan from J.P. Morgan in the amount of $5 million, Fu secured this loan with two million shares of
Plaintiffs characterize Fu's sales of his shares between October 22, 2008 and November 3, 2008 as "insider trading proceeds." (Docket Entry No. 57, Amended Complaint at ¶ 137). Plaintiffs allege that Defendant Fu had a motive to hide Fushi's financial condition and to continue the alleged fraudulent scheme because Fu had granted several loans to Fushi that carried the risk that they would not be paid back if the Fushi stock were unsuccessful. Id. at ¶ 139. These loans Fu allegedly granted were "non-interest bearing" and "due on demand" in July 2009 and September and October 2010 totaling over $35 million of his own money. Id. at ¶ 138.
Plaintiffs also cite Defendant Fu's undisclosed interest in Dalian Jinchuan and Hongtai entities that Fushi acquired as "bargain purchases" and Fu's financial gain from Fushi's acquisition of those entities. Id. at ¶ 140. A former high level executive identified Fu's ownership interest in Dalian Jinchaun as well as in a second company, the description the former Fushi officials were unable to give, other than as of comparable size to Hongtai's business. Id.
On November 3, 2010, Fu presented Fushi's board of directors with a proposal, a preliminary, non-binding offer, to purchase Fushi's outstanding shares at $11.50 per share. (Docket Entry No. 66-13 at 2). The announcement of Fu's offer generated eleven (11) legal actions
Plaintiffs assert that Fushi's executive compensation system motivated the Defendants to engage in these alleged frauds. Id. at ¶ 147. Plaintiffs cite Defendants' compensation as tied significantly to incentives: "Elements of executive compensation presently consist of base salaries, an annual cash incentive plan and equity compensation, such as stock options, in order to achieve a balance between cash and other compensation." Id. According to the Plaintiffs, during the Class Period, Defendants Fu, Longever, Wang, and Studwell received incentive compensation under the Performance Based Cash Incentive Plan. Id. at ¶ 148. Plaintiffs allege that Defendants were eligible for and received both "massive" payouts under Fushi's executive compensation policy as well as stock awards and option awards. Id. at ¶ 149. In addition, Defendants Fu, Longever, and Wang allegedly received a bonus award
Defendant Year Salary Bonus Stock Awards Option Awards Fu 2010 $240,000 $240,000 - 2009 $240,000 $ 50,000 - $113,000 2008 $240,000 $ 48,000 - $318,000 Longever 2010 $225,000 $225,000 - - 2009 $ 79,000 $ 30,000 $404,000 $856,000 2008 - - - - Wang 2010 $200,000 $200,000 $172,000 $ 86,000 2009 $200,000 $ 64,000 - $ 93,000 2008 $188,000 $ 40,000 - $127,000 Studwell 2010 $ 38,000 $ 41,000 $288,000 $737,000 2009 - - - - 2008 - - - -
Id. at ¶ 150.
Plaintiffs assert that these policies created an incentive for fraud by allowing executives to receive massive bonuses based on achieving Fushi's performance targets without any consequence to the executives, if the financial results were later determined to be false. Id. at ¶ 151. Plaintiffs assert that Fushi's system lacked any mechanism to recoup improvidently paid bonuses that provided a strong motivation for fraud and supports a strong inference of scienter. Id. at ¶ 152.
Plaintiffs allege, as discussed above, that Defendants' false and misleading statements artificially inflated the prices of Fushi securities and misrepresented Fushi's actual business and financial prospects. Id. at ¶ 153. Plaintiffs allege that as a result of the discovery of these misrepresentations and fraudulent conduct, the price of Fushi securities dropped precipitously, resulting in economic losses to Plaintiffs. Id. Plaintiffs assert that the alleged misrepresentations and omissions directly or proximately caused or were a substantially contributing cause to the damages sustained by Plaintiffs and members of the class. Id. at ¶ 154. Plaintiffs assert that these Fushi's misstatements created a market of unrealistically positive assessment of Fushi and its potential value, causing the Fushi's stock to be overvalued and artificially inflated during the Class Period. Id.
Fushi's disclosures of its actual financial condition caused its stock price to drop and Plaintiffs cite this drop as evincing Fushi's prior statements over the class period to be false. Id. at ¶¶ 155, 157-58. Plaintiffs assert that the timing and magnitude to Fushi's stock price decline negates inferences that the loss was a result of changed market conditions or other causes. Id. at ¶ 159. Rather, Plaintiffs assert the losses suffered by the class members were the direct result of the Defendants' fraudulent scheme to inflate artificially the value of Fushi stock. Id.
Plaintiffs also assert a presumption of reliance established by the fraud-on-the-market doctrine, contending:
Id. at ¶ 162.
Plaintiffs assert that the market for Fushi stock was efficient at all relevant times because:
Id. at ¶ 163.
For a Rule 12(b)(6) motion to dismiss, the Court must assess whether the complaint's factual allegations "raise a right to relief above the speculative level," that is, the claims must be "plausible". Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555-556, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). "[T]he allegations of the complaint should be construed favorably to the pleader." Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974) and the Court must "treat all of the well-pleaded allegations of the complaint as true." Miree v. DeKalb Cnty., Ga., 433 U.S. 25, 27 n. 2, 97 S.Ct. 2490, 53 L.Ed.2d 557 (1977). Yet, a legally sufficient complaint, "require[s] more than the bare assertion of legal conclusions[,]" Columbia Natural Res., Inc. v. Tatum, 58 F.3d 1101, 1109 (6th Cir.1995), and the district court "need not accept as true legal conclusions or unwarranted factual inferences." Morgan v. Church's Fried Chicken, 829 F.2d 10, 12 (6th Cir.1987).
Moreover, where, as here, fraud is alleged, Fed.R.Civ.P. 9(b) requires that "in all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." In a securities action, the heightened pleading standards are to be evaluated as set forth by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007):
Id. at 322-28, 127 S.Ct. 2499 (citations omitted) (emphasis added).
The Sixth Circuit recently restated the Supreme Court's precedent on a Rule 12(b) motion in a securities action as follows:
Frank v. Dana Corp., 547 F.3d 564, 570-71 (6th Cir.2008) ("Dana I"). As the Sixth Circuit stated recently:
Dana II, 646 F.3d at 961 (emphasis added).
In addition, the Sixth Circuit ruled that the provisions of Fed.R.Civ.P. 8 and the requirement of Rule 9(b) are to be read in conjunction with each other. Michaels Bldg. Co. v. Ameritrust Co., N.A., 848 F.2d 674, 679 (6th Cir.1988). In Blount Financial Services v. Walter E. Heller & Co., 819 F.2d 151 (6th Cir.1987), the Court explained that "Rule 9(b) requiring `averments of fraud ... with particularity' is designed to allow the District Court to distinguish valid from invalid claims in just such cases as this one and to terminate needless litigation early in the proceedings." Id. at 153 (citation omitted). Rule 9(b) is also intended "to provide a defendant fair notice of the substance of a plaintiff's claim in order that the defendant may prepare a responsive pleading." Am. Town Ctr. v. Hall 83 Assocs., 912 F.2d 104, 109 (6th Cir.1990) (citing Michaels Bldg. Co., 848 F.2d at 679).
Under Michaels Building Co. v. Ameritrust Co., 848 F.2d 674 (6th Cir. 1988), the plaintiff can satisfy Rule 9(b)'s requirements by pleading the circumstances of the fraud, not the evidence. Id. at 680 n. 9. Since Ameritrust, however, the Sixth Circuit reiterated the rule of this Circuit that Fed.R.Civ.P. 9(b) requires that fraud be pled with particularity. To satisfy Fed.R.Civ.P. 9(b), a plaintiff must "at a minimum
In addition, where the fraud claims involve multiple defendants, the alleged fraudulent conduct of each defendant must be set forth separately or otherwise the complaint is legally deficient under Rule 9(b). In Benoay v. Decker, 517 F.Supp. 490 (E.D.Mich.1981) (aff'd 735 F.2d 1363 (6th Cir.1984)), the district court stated:
Id. at 493 (quoting McFarland v. Memorex Corp., 493 F.Supp. 631, 639 (N.D.Cal. 1980), (quoting Jacobson v. Peat. Marwick, Mitchell & Co., 445 F.Supp. 518 (S.D.N.Y. 1977))).
More recently in City of Monroe Employees Retirement Sys. v. Bridgestone Corp., 399 F.3d 651 (6th Cir.2005), the Sixth Circuit noted a split in precedents, including a decision of a district court in this Circuit, on the "group pleading" exception to Rule 9(b). Id. at 689-90 n. 32. This exception applies "in cases of corporate fraud where the false and misleading information is conveyed in a prospectuses, registration statements, annual reports, press releases, or `other group published
As stated in Tellabs, "courts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice." 551 U.S. at 322, 127 S.Ct. 2499. In Weiner v. Klais & Co., Inc., 108 F.3d 86 (6th Cir.1997), the Sixth Circuit reiterated the general rule that: "Matters outside the pleadings are not to be considered by a court in ruling on a 12(b)(6) motion to dismiss." Id. at 88 (citations omitted). Yet, the Weiner Court recognized an exception in securities cases, but only for papers filed by a defendant and referred to a plaintiff's complaint.
Id. at 89 (emphasis added and citations omitted) (quoting Venture Assocs. Corp. v. Zenith Data Sys. Corp., 987 F.2d 429, 431 (7th Cir.1993); see also Nieman v. NLO, Inc., 108 F.3d 1546, 1555 (6th Cir.1997)).
In Beaver County Retirement Bd. v. LCA-Vision, Inc, No. 1:07cv 750, 2009 WL 806714 (S.D.Ohio Mar. 25, 2009), the district court explained that "[c]ourts may take judicial notice of information that was publicly available to reasonable investors at the time the defendant made the allegedly false statements." Id. at *4 (citing In re UnumProvident Corp. Sec. Litig., 396 F.Supp.2d 858, 876 (E.D.Tenn.2005) (citing Phillips v. LCI Int'l, Inc., 190 F.3d 609, 617 (4th Cir.1999))). This includes "the full text of the SEC filings, prospectus, analysts' reports and statements `integral to the complaint.'" Bovee v. Coopers & Lybrand C.P.A., 272 F.3d 356, 360 (6th
Based upon Sixth Circuit precedent, the Court will consider the SEC filings, but evaluate them in light of the allegations in the amended complaint. The Court will also consider, with exceptions, those documents referred to in Plaintiffs' amended complaint and the SEC and market reports submitted by the Defendants, (Docket Entry No. 66, Attachments thereto, and Docket Entry No. 83, Attachments thereto). The exceptions are the Wall Street Journal article that involves disputed facts. See Monroe Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 662 n. 10 (6th Cir.2005). The Court will not take judicial notice of the Muddy Water report nor Plaintiffs' Wall Street Journal articles (Docket Entry No. 77, Attachments thereto and Docket Entry No. 8, Attachments thereto) because these materials involve disputed facts and their "`existence or contents prove facts whose accuracy' are `reasonably questioned'" by the parties. LCA-Vision, 2009 WL 806714, at *4 (citing Passa, 123 Fed.Appx. at 697).
Plaintiffs' claims seek recovery under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j (2010), prohibits the use "in connection with the purchase or sale of any security ... [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe ... [.]" Pursuant to this section, the Securities Exchange Commission promulgated Rule 10b-5, that provides in pertinent part:
17 C.F.R. § 240.10b-5.
The Supreme Court described the purpose of the 1934 Act as follows:
Basic Inc. v. Levinson, 485 U.S. 224, 230, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (quoting Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-78, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977) (quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963))).
In 1995, Congress enacted the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. §§ 78a et seq. (2010), that requires specificity in pleadings in private securities litigation before commencement of discovery:
15 U.S.C. § 78u-4(b)(1)(A), (b)(2)(A) & (3)(A)-(B) (2010) (emphasis added).
The purpose of the PSLRA was to "protect investors, issuers, and all who are associated with our capital markets from abusive securities litigation" as well as to "implement[] needed procedural protections to discourage frivolous litigation." H.R.Rep. No. 104-369 at 32 (1995) (Conf. Rep.), 1995 U.S.C.C.A.N. 730, 731. Although Congress added the necessity of "strong inference," the Sixth Circuit later clarified that the PSLRA did not alter the recklessness standard for scienter in federal securities actions. In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 550 (6th Cir.1999).
In Sante Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), the Supreme Court stated that Section 10(b) did not encompass "instances of corporate mismanagement." Id. at 477, 97 S.Ct. 1292. Rather, "Section 10(b)'s general prohibition of practices deemed by the SEC to be `manipulative' in this technical sense of artificially affecting market activity in order to mislead investors is fully consistent with the fundamental purpose of the 1934 Act to substitute a philosophy of full disclosure for the philosophy of caveat emptor...." Id. at 476-77, 97 S.Ct. 1292 (quoting Affiliated Ute Citizens v. United States, 406 U.S. 128, 151, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972) (quoting Capital Gains Research Bureau, 375 U.S. at 186, 84 S.Ct. 275)). "No doubt Congress meant to prohibit the full range of ingenious devices that might be used to manipulate securities prices." Sante Fe Indus., 430 U.S. at 477, 97 S.Ct. 1292
As to the elements of a Section 10(b) claim, the Sixth Circuit recently restated the elements as follows: "To state a securities fraud claim under Section 10(b), a plaintiff `must allege, in connection with the purchase or sale of securities, the misstatement or omission of a material fact, made with scienter, upon which the plaintiff justifiably relied and which proximately
Plaintiffs assert multiple theories of liability for their Section 10(b) and Rule 10(b)(5) claims, namely: (1) that Defendants made misrepresentations or misleading statements about Fushi's actual financial condition and its profitability; (2) that the Defendants' treatment of the SWAP and bargain acquisitions failed to comply with GAAP and other financial standards causing a misleading overstatement of Fushi's income and profitability; (3) Fushi's compensation structure provided the individual Defendants the motive and opportunity for these misrepresentations; (4) that the Defendants' misstatements and practices caused material losses in the value of Fushi's stock; (5) the Defendants' concealment of Fushi's actual practices effected a fraud on the market; (6) that public disclosures of some facts do not bar Plaintiffs' claims; (7) that the Defendants did not disclose Defendant Fu's ownership of substantial amounts of Dalian Jinchuan stock; and (8) that liability of the individual Defendants' control is not subject to the heightened level of pleading.
The core of the Defendants' motion focuses on the sufficiency of Plaintiffs' allegations on the elements of materiality, scienter, loss causation and individual liability that involve overlapping factual allegations. In sum, Defendants contend that under relevant precedents, Plaintiffs' allegations are not actionable because: (1) Plaintiffs fail to allege any facts to suggest the lack of good faith or recklessness or wilfulness given Defendants' public disclosures and reliance on an outside auditor for its financial reports and accounting on the SWAP and "bargain acquisitions;" (2) at the time of the SWAP, it was factually impossible to know the SWAP'S effect on Fushi's income; (3) Fushi's restatements of its financial condition are not material nor evince a strong inference of scienter; (4) Plaintiffs's allegations of the Defendants' alleged knowledge and/or recklessness are conclusory; (5) Plaintiffs' allegations are also insufficient to meet the recklessness standard to impose liability based upon the Sox certifications; (6) Plaintiffs' allegations about a former unidentified executive are insufficient for the requisite scienter; and (7) that neither the secured insider loans nor stock tradings nor executive compensation is actionable.
Applying the holistic method of assessment of Tellabs, the Court reviews of Plaintiffs' specific allegations on each element of their securities claims, their theories of liability and the alleged role of each individual defendant in Fushi's alleged misstatements, omissions and/or conduct concerning Fushi's actual financial condition and practices.
Here, Plaintiffs allege that Fushi's misrepresentations and omissions are based upon Fushi's SEC reports and Defendants' statements to investors and analysts during conferences about whether its SWAP qualified for the accounting treatment and whether the Dalian Jichuan and Hongtai acquisitions qualified as "bargain purchase" acquisitions for favorable accounting treatment. These written and oral statements benefitted Fushi by attracting investors. The alleged falsity of these statements to investors is reflected in the Defendants' subsequent announcements that none of these transactions qualified under the GAAP standards for the specialized treatment that favorably impacted Fushi's financial condition. In addition, Plaintiffs allege that Fushi's SEC reports, statements on conference calls and press statements about its financial conditions were materially misleading about Fushi's GAAP compliance and actual
Plaintiffs also cite Defendant Longever's statements attributing the disappointment in Fushi's financial performance to Fushi's customers' decisions in not "restocking" their inventories and maintaining those inventories "at only a minimal levels." (Id. at ¶ 126). Plaintiffs cite two former Fushi employees who state "Fushi's customers did not keep inventory on hand or have warehouses for inventory." Id. at ¶ 128. The Defendants also failed to disclose Fu's ownership interests in the bargain purchases acquisitions. Id. at ¶¶ 54, 140-41.
Plaintiffs' first set of claims evolves around the Defendants' initial statements about Fushi's SWAP, the SWAP'S positive effect on Fushi's net income and the Defendants' subsequent disclosures about the SWAP and impropriety of the adverse effects on Fushi's financial condition. Courts describe a SWAP as a category of market agreements on cash flow that firms employ in the marketplace to adjust to variable interests and changes in the values of currency:
Procter & Gamble Co. v. Bankers Trust Co., 925 F.Supp. 1270, 1275 (S.D.Ohio 1996).
In Procter & Gamble, the district court noted the varying views about the SWAPs as a financial instrument:
Id. at 1275-76 (emphasis added and footnote omitted).
As to the financial effect of a SWAP agreement that involve interest rates, in Yountville Investors, LLC. v. Bank of America, N.A., No. C08-425RSM, 2009 WL 2342462 (W.D.Wash. July 28, 2009), the Court observed:
Id. at *2 (quoting Thrifty Oil Co. v. Bank of Am. Nat'l Trust & Sav. Ass'n, 322 F.3d 1039, 1042-43 (9th Cir.2003) (emphasis added)). In 2010, the Dodd-Frank Act amended the definition of a security to include SWAPs. 15 U.S.C. § 78c.
Here, Plaintiffs allege that Fushi's SWAP was a "plain vanilla" SWAP that according to Plaintiffs, is not complicated under GAAP standards. Plaintiffs allege that Fushi's SWAP, in fact, did not qualify for the accounting treatment as stated in Fushi's SEC form. Defendants admitted this noncompliance in Fushi's SEC filings. The disqualification of the SWAP allegedly arose from the fact that Fushi's long term debt never faced any risk with variations in interest rates. This lack of qualifications is reflected in the Defendants' 2011 disclosures about the SWAP. Thus, Fushi's SWAP lacked any apparent purpose other than the effect of significantly increasing Fushi's income and attractiveness to investors. The significant rise in Fushi's net income after the SWAP (24% in the first quarter) could reasonably attract investors. Plaintiffs allege that with the Defendants' stated noncompliance with simple accounting standards for a "plain vanilla" SWAP, the Defendants either knew or recklessly disregarded the SWAP'S allegedly clear ineligibility. Defendants respond that because the SWAP was disclosed to investors, such disclosure precludes any suggestion of scienter.
As to the Fushi acquisitions, the Defendants initially gave the "bargain purchase" accounting treatment to the value of those acquisitions. This "bargain purchase" accounting caused Fushi to realize a total of $5.1 million in the first and second quarters of 2010. (Docket Entry No. 57, Amended Complaint at ¶ 31). Plaintiffs allege that Fushi failed to meet its projected financial goal in the first quarter of 2011, after the 2010 acquisitions by 39 %. Id. at ¶ 127. The Court concludes that these facts alone reflect material misstatements and omissions about Fushi's actual
To accept the Defendants' contention on the SWAP disclosure would effectively eviscerate the 2010 amendments to Dodd-Frank to include SWAP as a security. Given the complex and manipulative nature of a SWAP, a reasonable investor may reasonably be unable to appreciate the significance and appropriateness of a particular SWAP. The reasonable investor is entitled to rely upon the Defendants' representations about the appropriateness of the SWAP. Given the Defendants' admitted misrepresentation of the purpose of its SWAP that can be manipulated, the Court concludes that Plaintiffs' allegations about the Defendants' SWAP present reasonable inferences of scienter.
As to the cumulative effect of the SWAP and acquisitions accounting improprieties, given that the Defendants are required to file SEC reports on a quarterly basis and conduct quarterly conferences with investors who purchase or advise clients to purchase Fushi stock, the Court concludes that any analysis based upon four years is unjustified. Moreover, viewed cumulatively, Plaintiffs cite a Jeffries analyst's statements that "we do consider [the Defendants' restatements] material to earnings, as they all exceed 8%." Id. at ¶ 123.
With Plaintiffs' factual allegations about Fushi's SWAP, coupled with the bargain purchase acquisitions that were also improperly classified for accounting purposes and caused the restatement of Fushi's income for four years as well as a material drop in the value of Fushi stock price, the Court concludes that Plaintiffs plausibly allege actionable misstatements and omissions about Fushi's actual finances and related business practices.
As to the Sarbanes-Oxley certifications, courts have declined to treat corporate officers' signatures for such certifications, as a per se violation, where, as here, accounting errors or mistakes are revealed by a subsequent audit. Ley v. Visteon Corp., 543 F.3d 801, 812 (6th Cir.2008) ("We agree with the Eleventh Circuit that a `Sarbanes-Oxley certification is only probative if the person signing the certification was severely reckless in certifying the accuracy of the financial statements'") (citation omitted). In Garfield v. NDC Health Corp., 466 F.3d 1255 (11th Cir. 2006), the Eleventh Circuit stated "If we were to accept [Plaintiffs'] proffered interpretation of Sarbanes-Oxley, scienter would be established in every case where there was an accounting error or auditing mistake made by a publicly traded company, thereby eviscerating the pleading requirements for scienter set forth in the PSLRA." Id. at 1266. Yet, Section 10(b)(5) claims are stated where, the Defendants' false statements about a corporation's financial condition when the corporate controls were known to be inadequate. Dana II, 646 F.3d at 961 (Defendants "ask us to infer that failed accounting systems are to blame here, and we find that inference plausible. However, the inference that [the Defendants] recklessly ignored the falsity of their external statement is at least as plausible as faulty accounting."); see also In re Phycor Corp. Sec. Litig., No. 3:98-0834, slip op. at 6 (M.D.Tenn. Feb. 17, 2000).
Here, the Sox certifications expressly reflect the signatories' assurances to investors of adequate internal controls of Fushi's finances, including accounting and GAAP compliance. The Individual defendants certified to investors, inter alia that they had "Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide
To be sure, Defendants contend that many of the statements cited by Plaintiffs in Defendants' reports and conferences were forward looking statements that the PSLRA precludes as bases for a securities claims, citing 15 U.S.C. § 78u-5(c)(1), related to or stated to be dependent on those historic or present tense statements when made.
Plaintiffs assert that Fushi's verbal "Safe Harbor" warnings accompanying its oral forward-looking statements issued during the Class Period are ineffective to shield those statements from liability. Id. at ¶ 160. Plaintiffs assert that Defendants are liable for any false or misleading FLS because the speakers allegedly knew at the time that these forward looking statements were false or misleading when made and such statements were authorized by Fushi executives who knew their content to be false. Id. at ¶ 161. Plaintiffs allege that none of the historic or present tense statements made by Defendants were assumptions underlying or relating to any plan, projection, or statement of future economic performance, as they were not stated to be such assumptions underlying or relating to any projection or statement of future economic performance when made, nor were any of the projections or forecasts made by Defendants expressly. Id.
On the issue of whether Plaintiffs' allegations present hard or soft information, under Sixth Circuit precedents, "[h]ard information `is typically historical information or other factual information that is objectively verifiable.' Such information is to be contrasted with `soft' information which includes predictions and matters of opinion and are not actionable." In re Sofamor Danek Group, Inc., 123 F.3d 394, 401 (6th Cir.1997) (quoting Garcia v. Cordova, 930 F.2d 826, 830 (10th Cir.1991)); accord Zaluski v. United Am. Healthcare Corp., 527 F.3d 564, 572 (6th Cir.2008). "The failure to disclose soft information is actionable only if it is virtually as certain as hard information." Bridgestone, 399 F.3d at 669 (quotation omitted). As examples, the Sixth Circuit defines "generalized statements of optimism that are not capable of objective verification" as "puffing" statements. In re Ford Motor Co. Sec. Litig., 381 F.3d 563, 570 (6th Cir.2004). In Ford, the Sixth Circuit held that Ford's statements related to "quality" of its vehicles were not actionable as mere puffing. Id. As another example, in Bridgestone, the defendant's statement that its tires were "the best tires in the world" was held not to be actionable as a matter of law:
399 F.3d at 671.
Here, the Defendants' statements about the SWAP'S and bargain acquisitions eligibility for favorable accounting treatment and Defendants' adequate internal controls
Plaintiffs allege Fushi's alleged misrepresentations and omissions were material because of favorable effects of the SWAP and "bargain purchase acquisitions" upon Fushi's actual financial conditions in the last three quarters of 2007, the years of 2008 and 2009, and the first three quarters of 2010. (Docket Entry No. 57, Amended Complaint at ¶ 60). The initial effects of the Fushi SWAP increased Fushi's net income by 24% in 2007 and the "bargain purchase" acquisitions had a demonstrable and positive initial impact on Fushi's financial condition and on Fushi's attractiveness to investors. Id. at ¶ 4. Moreover, viewed cumulatively, Plaintiffs cite a Jeffries analyst's statements that "we do consider [the Defendants' restatements] material to earnings, as they all exceed 8%." Id. at ¶ 123.
Section 10(b) and Rule 10b-5 Section 10(b) extend to prohibit material misrepresentations and/or omissions where there is "[the commission] of a manipulative or deceptive act in connection with the purchase or sale of securities." Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994). "[T]o fulfill the materiality requirement `there must be a. substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available.'" Basic, Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). In Basic, the Supreme Court referred to information "such as earnings forecasts or projections" as "contingent or speculative information." Id. at 232 n. 9, 108 S.Ct. 978. The Supreme Court, however, did not decide that issue. Id.
In Bridgestone, the Sixth Circuit noted that at the motion to dismiss stage, omissions should be considered material unless the omitted information was so "obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their unimportance." Bridgestone, 399 F.3d at 681 (quotation omitted); see also Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir.2000) (quoting; Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir.1985)); Arber v. Essex Wire Corp., 490 F.2d 414, 418 (6th Cir. 1974) (The test for materiality is "whether a reasonable man would have attached importance to the undisclosed facts in determining his choice of action in the particular transaction in question."). The materiality requirement does not require that the defendant communicated the misrepresentation directly to the plaintiff. In re Kidder Peabody Sec. Litig., 10 F.Supp.2d 398, 407 (S.D.N.Y.1998). Unless written misrepresentations are material, such misrepresentations are not actionable. Radol v. Thomas, 772 F.2d 244, 252 (6th Cir.1985). In any event, "the district court should decide the issue of materiality as a matter of law only if the alleged misrepresentations are so clearly and obviously unimportant that reasonable minds could not differ in their answers to the question" In re Envoy Corp. Sec. Litig., 133 F.Supp.2d 647, 662 (M.D.Tenn.2001) (quoting Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir.2000)).
Defendants' principal contention on lack of materiality is that when viewed in the context of the four year period of the restatements, the actual effect of Fushi's restatement (4% loss of net income) fails to meet the standard of materiality for a securities claim. (Docket Entry No. 69, Defendants' Memorandum at 23, 27)
In response, Plaintiffs note that Fushi's employment of the SWAP led to 24% overstatement of its income in 2007. (Docket Entry No. 57, Amended Complaint at ¶ 29). This 24% increase in 2007 would be a material fact to an investor who decided to purchase Fushi stock in 2007 based upon Defendants' statements about Fushi's financial condition in 2007. Plaintiffs cite financial analysts who assessed Fushi's restatement stating that "we do consider [the restatements] material to earnings as they all exceed 8%." Id. at ¶ 123. Plaintiffs also allege that Fushi's audit committee that prepared the restatements deemed the accounting errors "material." Id. at ¶ 10. Plaintiffs cite precedent, Ganino and the authorities cited therein, that a 2% overstatement of income can be actionable. (Docket Entry No. 76, Plaintiffs' Response at 18, citing Ganino, 228 F.3d at 164).
In Ganino, the Second Circuit stated that misstatements of a firm's income involves material facts because "`earnings reports are among the pieces of data that investors find most relevant to their investment decisions' and that the `materiality is determined in light of the circumstances existing at the time of the alleged misstatement occurred.'" Id. at 165 (quoting In re Burlington Coat Factory, 114 F.3d 1410, 1420 n. 9 (3d Cir.1997)). As to Defendants' reliance on Konkol, in light of Matrixx Initiatives and Dana II, the analysis described in Konkol is not controlling. Konkol, 590 F.3d at 400. As noted in SCB Comp., courts differ on this issue of the extent of the accounting errors. 149 F.Supp.2d at 359 (collecting citations). Given that investors purchased stock at different times covering a period of years and given that Defendants' report on these financial sales quarterly, the fall in Fushi's stock prices after the restatement because of the SWAP and Fushi's "bargain purchase" acquisitions, is a relevant on the materiality issue. See In re Omnivision Technologies, Inc., No. C04-2297SC, 2005 WL 1867717, at *3 (N.D.Cal. July 29, 2005) ("the investing community finds improper revenue recognition incidents to be serious matters regardless of the direction of the improper recognition"). To be sure, some courts hold that where the claim is based solely on the restatement of income, the restatement must be substantial SCB Computer, 149 F.Supp.2d at 359: In re The Goodyear Tire & Rubber Co. Securities Litig., 436 F.Supp.2d at 894. Yet, here the materiality focuses upon the financial appeal of the SWAP and acquisitions to investors during the time period of those transactions.
Under Matrixx Initiatives and Dana II, these accountings allegations must be evaluated with the "collective facts" of the case. Given the effect of the SWAP generating the 24% increase in Fushi's net income, the capacity of a SWAP to enhance falsely a firm's actual financial
Plaintiffs' allegations of scienter overlap with their factual allegations on the materiality element, namely: (1) that Fushi's SWAP, increased its income 24% in one quarter that later "increased 50%" for 2007, but Fushi was never exposed to any foreign exchange currency risks on Fushi's high yield notes to justify a SWAP; (2) that Defendants recklessly disregarded the fact that with the SWAP, the Renminbi/United States exchange rate could not off set the London Interbank Offered Rate; (3) that the Defendants' failed to disclose Fu's interest in the bargain purchases; (4) that Defendants failed to disclose Fu's ownership interest in Dalian Jinchuan and Hongtai acquisitions; (5) that Defendants did not in fact have any internal controls over its finances as reflected by Defendant Fu's alleged total control; (6) that former Fushi executives expressed fears of going to jail for Fushi's accounting practices; and (7) that based upon statements of former Fushi executives, Longever made false statements about Fushi's the customers inventory practices as the cause of Fushi's drop in profitability. (Docket Entry No. 57, Amended Complaint at ¶¶ 37-47, 54, 72 & 140-41).
Defendants' principal challenges to these allegations as bases for a strong inference of scienter are, in sum: (1) that as a matter of law, accounting errors do not give rise to strong inferences of scienter; (2) Fushi's public disclosures in its SEC filings about the SWAP transactions; (3) that the Defendants relied upon independent auditors for the accounting appraisals of its SWAP and its "bargain purchase" acquisitions of Dalian Jinchuan and Hongtai; (4) that the effect of the disqualifications of the SWAP and bargain purchase acquisitions caused a restatement resulting in a total 4% reduction in Fushi's income over the four year period of the restatement; (5) that there is no tie between Fu's 2008 stock sale and 2009 interest free loan to Fushi and the 2007 SWAP transaction or the 2010 "bargain purchase" acquisitions; (6) that there is no tie between the 2010 bonuses to any questionable transaction; (7) that hearsay and conclusory statements of former executives are inadequate for any strong inference of scienter; (8) that Fushi's termination of its auditors after announcement of the accounting disqualifications does not evince scienter; (9) that the Defendants' March 11, 2011 statement is a forward looking statement that is not actionable; and (10) that Plaintiffs' fail to allege any facts to suggest the lack of good faith in their public statements. (Docket Entry No. 69, Defendants' Memorandum in Support of Motion to Dismiss at 22-32).
If the complaint fails to satisfy the scienter requirement, the Court must dismiss Plaintiffs' complaint upon a motion of the defendant. 15 U.S.C. § 78u-4(b)(3). "The Supreme Court has held that `scienter' is a `mental state embracing intent to
In the Sixth Circuit, a company's restatements of its finances involving millions of dollars has been rejected as evincing scienter. PR Diamonds, 364 F.3d at 684. In this Circuit, "[t]he failure to follow GAAP is, by itself, insufficient to state a securities fraud claim." In re Comshare, 183 F.3d at 553 (citations omitted). To give rise to an inference of scienter, accounting violations must be of a "type and scope" to be "obvious" or to show the "`magnitude,' `pervasiveness' and `repetitiveness' of the company's violations of `simpl[e] accounting principles' ... amounting to a night-and-day difference." PR Diamonds, 364 F.3d at 684-85 (quoting In re MicroStrategy, Inc. Sec. Litig., 115 F.Supp.2d 620, 635-37 (E.D.Va.2000)). For accounting errors alone to suffice, the Plaintiffs must also allege facts of "highly unreasonable conduct which is an extreme departure from the standards of ordinary care. While the danger may not be known, it must at least be so obvious that any reasonable man would have known of it." In re Comshare, 183 F.3d at 550.
For accounting errors, Plaintiffs allegations must state facts "that Defendants knew or could have known of the errors or that regular procedures should have alerted them to the errors sooner than they actually did." Id. at 553. Moreover, in the Sixth Circuit, misleading financial presentations that are intended to confuse rather than illuminate investors, can provide a strong inference of scienter. Bridgestone, 399 F.3d at 684. PR Diamonds cited approvingly of precedent that found a strong inference arising where the company "touted the Individual Defendants' careful monitoring of the very areas in which Internet committed accounting violations." 364 F.3d at 688 (citation omitted). Moreover, accounting errors can be "viewed in combination with other allegations." Id. at 686. Based upon PR Diamonds and In re Comshare, the Court concludes that Fushi's restatement alone does not give rise to a strong inference of scienter, but "GAAP violations ... along with other circumstances, can create a strong inference of scienter." In re Envoy Corp. Sec. Litig., 133 F.Supp.2d 647, 660 (M.D.Tenn.2001). Moreover, disclosure of accounting information understandable only by a person with a high degree of sophistication, if false, may give rise to an inference of scienter. In re Kindred Healthcare, Inc. Sec. Litig., 299 F.Supp.2d 724, 741 (W.D.Ky.2004).
In any event, as stated earlier, the holistic approach now controls. The Court concludes that under the holistic standard of review Plaintiffs' factual allegations about accounting issues must be assessed with the other factual allegations about the Defendants' statements, conduct and omissions involving the SWAP and bargain acquisitions. The SWAP raised Fushi's income by 24%. The Court notes that in Dana II, the Sixth Circuit found a strong inference of scienter where the defendants allegedly "overstated its net income for the first quarter of 2004 by twelve percent, the second quarter of 2004 by ten percent, the
Here, Plaintiffs' allegations are that from an accounting perspective, Fushi's SWAP was "plain vanilla." Yet, a SWAP involves a complex accounting transaction that is "`a powerful tool for altering the character of assets and liabilities,'" Yountville Investors, 2009 WL 2342462 at *2 (citation omitted), and can be "a financial Jurassic Park." Procter & Gamble, 925 F.Supp. at 1276. Thus, a SWAP'S terms and implications may not be understood by an ordinary reasonable investor. This fact, coupled with the fact, that Fushi
Fushi's restatements of these errors precluded timely compliance with an SEC report that gives rise to a strong inference about the serious magnitude of the Defendants' accounting mistreatment of these transactions. The "magnitude of [the] false statements are relevant to the scienter element. Dana II, 646 F.3d at 960 As one court recognized in similar circumstances:
In re Sipex Corp. Sec. Litig., No. C05-00392WHA, 2005 WL 3096178, at *1 (N.D.Cal. Nov. 17, 2005).
Plaintiffs also cite Fu's undisclosed ownership interests in at least one of the acquired entities, Jichuan Dalain, as well as Fu's alleged insider trading and Fu's alleged total control of Fushi's finances. A related allegation is Fushi's executive compensation system that paid bonuses of 100% of the individual Defendants' salaries. Plaintiffs allege each of these facts created the motive and opportunity for the Individual Defendants to act with the requisite scienter. In this Circuit "an executive's desire to protect his position within a company or increase his compensation" does not "comprise a motive for fraud," PR Diamonds, 364 F.3d at 690, nor are allegations that Defendants would receive bonuses linked to company performance sufficient for an inference of scienter. In re Kindred Healthcare, 299 F.Supp.2d at 741. Yet, "`self-interested motivation of defendants in the form of saving their salaries'" can support scienter. Bridgestone, 399 F.3d at 687 (quoting Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir.2001)). "A very difficult position" and "unusual pressures to perform," coupled with other factors, can provide an inference of improper motive. Telxon, 133 F.Supp.2d at 1029. The Court concludes that if regular compensation is commensurate to the executive's service to the company, then Plaintiffs' allegations that the individual Defendants' had the ability to enhance their compensation by 100% of their regular compensation creates an inference of "unusual pressures to perform" Id.
As to insider trading, "[a] company's decision to reinvest its own stock undermines an inference of scienter because it presumably would make no sense to purchase that stock if defendants knew the prices to be inflated." Morse, 200
Under the collective factual allegations presented by the Plaintiffs, the Court concludes that Plaintiffs have alleged facts giving rise to strong inferences of scienter so as to state actionable claims under Section 10(b).
Defendants next assert Plaintiffs have not suffered any actionable losses because on March 11, 2011, the day of Defendants' announcement of its restatements, a tsunami struck Japan. Financial press reported that Asian stocks were the hit hardest following the natural disaster on March 11 and, for that and other reasons, and Defendants needed an extension of time to file its 2010 Form 10-K. Although Fushi's share price at the close of March 11, 2011 was $9.42 per share. (Docket Entry No. 66-7 at 5, Stock Price Report). On March 14, 2011, the next trade day, Fushi's stock closed at $8.68 per share. Id. According to Defendants, the Dow Jones Industrial Average declined on March 14, but rallied late in the day to close down only 51.24 points. Defendants assert that Fushi's stock price climbed following the release of the Defendants' restatement. As described earlier, Plaintiffs' allegations and cited market reports are to the contrary. See (Docket Entry No. 57, Amended Complaint).
The PSLRA provides that "the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this [chapter] caused the loss for which the plaintiff seeks to recover damages." 15 U.S.C. § 78u-4(b)(4). Fed. R.Civ.P. 8(a)(2) requires that Plaintiff plead "the relevant economic loss." Moreover, Plaintiffs' complaint must provide some basis for a causal connection between plaintiffs' loss and defendants' misconduct. Dura Pharms. v. Broudo, 544 U.S. 336, 347, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005).
In Dura, the Supreme Court noted that the pleading requirements for loss causation "are not meant to impose a great burden upon a plaintiff," id., but a plaintiff must allege "a causal connection between the material misrepresentation and the loss." Id. at 342. The plaintiff must allege that the misrepresentations or concealment affected the market or became generally known to the market and thereby caused a company's stock price to decline. See Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2d Cir.2005) (plaintiffs must allege that the purported misstatements or omissions "concealed something from the market that, when disclosed, negatively affected the value of the security"); see also Initial Pub. Offering, 399 F.Supp.2d 261, 266 (S.D.N.Y.2005) ("[A] failure to meet earnings forecasts has a negative effect on stock prices, but not a corrective effect.... It does not disclose the scheme; therefore, it cannot correct the artificial inflation caused by the scheme.") Yet, general allegations linking drops in stock price to disclosures of financial
The Court concludes that Plaintiffs' allegations are sufficient for such causation under Fed.R.Civ.P. 8 and Dura, with the decline of Fushi's stock after Defendants' announcement of the restatements involving the SWAP and bargain acquisition. Moreover, with Plaintiffs' fraud on the market theory, Plaintiffs and the Class have suffered damages in that, in reliance on the integrity of the market, Plaintiffs paid artificially inflated prices for Fushi's publicly traded securities. See D.E. & J. Limited P'ship v. Conaway, 133 Fed.Appx. 994, 999, 1001 (6th Cir.2005); see also Semerenko v. Cendant Corp., 223 F.3d 165, 186-87 (3d Cir.2000) ("So long as the alleged misrepresentations were a substantial cause of the inflation in the price of a security and in its subsequent decline in value, other contributing forces will not bar recovery."). Moreover, as the Second Circuit recently held a bounce back of the stock's value after an initial drop does not preclude a Section 10(b) claim. Acticon AG v. China N.E. Petroleum Holdings, Ltd., 692 F.3d 34, 40-42 (2d Cir.2012).
As to the Defendants' contention of alternate causes of Plaintiffs' losses, the Court agrees with the Seventh Circuit that "it is possible for more than one cause to affect the price of a security and, should the case survive to that point, a trier of fact can determine the damages attributable to the fraudulent conduct." Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645, 649 (7th Cir.1997). Defendants' contentions lack merit at the pleading stage.
Section 20(a) of the 1934 Act, 15 U.S.C. § 78t (2010), and Section 15 of the 1933 Act, 15 U.S.C. § 77o (2010), impose legal responsibilities upon the "controlling person" in a publicly traded company for violations of the Securities Act by their agents, subject to certain defenses. Section 15 of the 1933 Act provides as follows:
15 U.S.C. § 77o. Similarly, Section 20(a) of the 1934 Act provides:
15 U.S.C. § 78t (2010).
Under federal securities law, the controlling person must be an actual participant and in control of the specific activity at issue. "[E]ssential elements" for a control person is of "power to control the specific transaction or activity upon which the primary violation is predicated"
In Bomarko, Inc. v. Hemodynamics, Inc., 848 F.Supp. 1335, 1339 (W.D.Mich. 1993), that court explained as to corporate officials:
Id. at 1032 (quoting Herm v. Stafford, 663 F.2d 669, 684 (6th Cir.1981)). See also In re Telxon Corp. Sec. Litig., 133 F.Supp.2d 1010 (N.D.Ohio 2000).
As to the individual Defendants' liability as controlling persons, "high-level executives can be presumed to be aware of matters central to their business's operation." PR Diamonds, 364 F.3d at 688. "Courts may presume that high-level executives are aware of matters related to their business' operation where the misrepresentations as omissions pertain to `central, day-to-day operational matters.'" Cardinal Health, 426 F.Supp.2d at 724. This is particularly appropriate for "[f]acts critical to a business's core operations." In re Ancor Commc'ns, 22 F.Supp.2d 999, 1005 (D.Minn. 1998). A company's chief executive officer who regularly participates in meetings, signs SEC filings and participates in earnings announcements can be sufficiently involved so as to raise strong inference of scienter. In re Envoy Corp. Sec. Litig., 133 F.Supp.2d 647, 663-64 (M.D.Tenn.2001). In In re Direct General Corp. Securities Litigation, 398 F.Supp.2d 888 (M.D.Tenn.2005), the Honorable Todd J. Campbell, then Chief Judge, held that plaintiffs' § 20(a) claims were sufficiently pled against that corporate defendant's top officers "because of their respective positions in the company, were each involved in the day-to-day management of [Defendant Company]" and "controlled and/or possessed the authority to control the contents of [Defendant Company]'s reports, press releases and presentations to the public and, through that power, fraudulently misled the investing public." Id. at 898.
Under SEC rules, the Individual Defendants' responsibilities include:
SEC Rule 13a-15(e), 17 C.F.R. 240.13a-15(e); SEC Rule 15d-15(e), 17 C.F.R. 240.15d-15(e).
For the above stated reasons, the Court concludes that under the holistic standard of review, Plaintiffs have alleged sufficient specific facts that collectively state actionable claims under Section 10(b), Rule 10b-5 and Section 20(a). Accordingly, the Defendants' motion to dismiss should be denied.
An appropriate Order is filed herewith.
In accordance with the Memorandum filed herewith, the Defendants' motion to dismiss (Docket Entry No. 68) is
It is so
